2) The index model has been estimated for stocks A and B with the following results:

RA = 0.06 + 0.5RM + eA. RB = 0.12 + 0.39RM + eB. M = 0.25; (eA) = 0.16; (eB) = 0.20.

a) What is the covariance between the returns on stocks A and B? [10 marks]

b) Without performing any calculation, determine which of the two stocks has higher systematic risk? Explain your answer. [10 marks]

c) Compute the two components (firm-specific and systematic) of the total risk for each of stock A and B? [25 marks]

d) Assuming that the risk-free rate is constant at 3%, calculate the new intercept for the non-modified version (in terms of total returns r instead of excess returns R ) of the SIM model for stock A.